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Is Trading of Gold/Silver a Zero Sum Game?

January 7, 2014

Today (January 7), I had an email conversation with Bob Moriarty of Bob claims that there is no such trade as a ‘naked short’ and he also claims that when trading commodities the result (of trading) is a Zero Sum Game. Is Bob correct on this assertion? Let’s think about these claims given today’s algorithmic trading markets. Do our speed of light markets with some 70% of all trading now being done artificially via pre-programmed algorithms qualify as legitimate trading (resulting in a zero sum after the trade). Let’s review some history of trading to discern how events have changed in recent years.

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If Bob and I were the only two people on this planet and we traded a one ounce silver coin using today’s currency (the dollar) would this trade represent a zero sum outcome? I would suggest, yes. If I buy the above coin from Bob (the seller) we have a legitimate trade as we both have agreed upon the ‘value’ (in dollars) of this trade and also executed the transaction. There is a buyer and a seller both negotiating personally and openly with each other. The result of the trade could be viewed as a Zero Sum event. Bob receives an equal ‘value’ (in dollars) and I receive an equal ‘value’ via the one ounce silver coin. This assumes that both Bob and I are generally equally aware and informed about this transaction and its valuation.

A definition of Zero Sum could be: a zero-sum game is a mathematical representation of a situation in which a participant’s gain (or loss) of utility is exactly balanced by the losses (or gains) of the utility of the other participant(s). If the total gains of the participants are added up, and the total losses are subtracted, they will sum to zero. 

Now let’s fast forward to today’s electronic/computer/algorithmic trading and create another example which many call the ‘naked short’ trade. Today I can execute a trade (buy/sell transaction) without any human element being involved. Today, we have what many call High Frequency Trading and also Algorithmic Trading. This type of trading (I would suggest) can result in a NON-Zero Sum result/event. Today, I can pre-program my HFT computer to execute both a short sale and a cancellation of this short sale within milliseconds/seconds/minutes. The computer program executes the short (acting as a seller) and the computer counterparty (at the broker’s exchange) executes the cancellation and/or acts as the buyer. This is an example of a fully automated trade. What else happens?

Algorithmic trading uses the computer for all transactions. The human element is ignored and abolished! This computerization creates the reality of a ‘naked short’ and ‘phantom’ shares!

If I have my computer programmed to sell (short) a million shares of GLD or SLV (or similar within the Comex market) my computer program can execute this short sale (which becomes a naked short sale) within milliseconds driving the PRICE of gold or silver DOWN. I can then CANCEL my short (via another pre-programmed computer algorithm) also within milliseconds (assuming the market maker or exchange allows this transaction). The result of this automated transaction is that I have sold phantom (non-existing) shares of gold or silver (which did not originally exist and which do not represent any borrowed shares). The result of this phantom transaction is that the PRICE of gold or silver declines due to the phantom nature of the extra shares entering the market process. This type of event is supposed to be illegal but since we now trade via HFT computers and use pre-programmed Algorithms for many trades this process allows events which we can call NAKED SHORTS.

Notice the GREEN line. This sharp drop in the silver PRICE could have resulted from a ‘naked short’ (computerized transaction)!

Since non-existing or phantom shares enter the market process during these types of trades, we should not call these events ZERO SUM. In reality, these events distort legitimate trading and create phantom buyers/sellers which our computers use for their transactions. This phantom nature did not happen when all our markets operated via the Open Outcry System. Today, however, most trades are executed (on the buy and sell side) via Algorithms and/or HFT computers.  These events happen within milliseconds/seconds/minutes on our electronic exchanges. This creates a whole new trading market where MANIPULATION and imaginary trades can be executed to affect market PRICES (up and down).  This is how I interpret today’s trading markets and many others seem to think that today’s markets are RIGGED and MANIPULATED by our high-speed computers. What do you think?

Does Bob Moriarty of have it correct when he states that there is no such thing as a ‘naked short’? Is he correct when he states that all our markets operate on a Zero Sum basis? My personal sense is that Bob has not fully understood today’s computerized markets. These markets are mostly automated markets were pre-programmed algorithms execute the trades. Many traders today set their algorithms after the markets have opened and then go to Starbucks (or similar) to enjoy a cup of coffee while their computers execute their trades. After the trading day ends (or their trading session ends) traders often sell all their positions and retain their results in CASH until the next trading day. In other words, most traders desire to trade while a market is open and active and then get out of all trades at the end of the day.

Today, most traders could care less about a company’s fundamentals, management, or profit goals. Computers execute math and numbers so all they are interested in is PRICE (of a commodity, stock, or asset). Traders desire to execute trades based on what they call ‘money flows’, ‘immediate trends’, ‘changes is immediate volumes, etc. Money is made/lost in the real-time markets and the COMPUTER is the proxy for a human trader today. Practically, all our Exchanges have been transformed into electronic exchanges where HFT and similar computers execute the vast majority of trades. We live in a NEW world of digital money, virtual reality, cyberspace, phantom shares, naked short selling, and rigged/manipulated markets. Is any of this criminal or not? What is your view?  I am:

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